The Other Bear Market

The Other Bear Market

The run on Russia.

Surely it cannot have surprised anyone to learn that Russia is run by crooks. The question has always been: What kind of crooks are they? Are they serious kleptocrats, in it for the long haul, or are they looters, out to take the money and run? The essence of the financial crisis that has rocked the world in the last few weeks is this: Investors, which means anyone with money at stake, appear to have decided, once and for all, that the men who run Russia are not only corrupt but shortsightedly so--that they are looters rather than kleptocrats.

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Of course, to get at this essence you have to dig a little. On the surface, Russia's troubles seem like the sort of thing that happens even to respectable countries. Even basically well-governed nations are subject to currency crises--remember, George Soros became a household word with his 1992 attack on the British pound. Nor are banking problems necessarily confined to places with unstable or corrupt governments; the case of the Texas thrifts comes to mind, and even squeaky clean Sweden had a banking debacle in the 1980s. So you might think that Russia's woes are simply a souped-up version of the kind of financial crises many countries have experienced. Indeed, if you read the official reports of the International Monetary Fund and the World Bank, that's the way they portray things.

But these surface similarities deceive. Britain was vulnerable to speculators in 1992, because there was a sound, if not universally accepted, economic case for devaluation. The country's overvalued currency was contributing to its high unemployment rate. (Hong Kong is vulnerable to speculators right now for the same reason.) Russia today, by contrast, is a largely de-monetized economy, in which many, perhaps most, transactions take place through barter. As far as most of the economy is concerned, the value and even the existence of the ruble have become more or less irrelevant. Nor are the Russian banks that have just crashed really banks in the Western sense of the word. By and large they have few depositors. Mainly they are in the business of borrowing money from foreigners and using it to speculate in Russian markets, above all in the market for government debt. Essentially, instead of borrowing money directly from foreigners, the Russian government has relied on a layer of politically connected middlemen to act as conveyors of foreign funds.

This wouldn't matter so much, except that that government borrowing has spiraled out of control. The reason is not excessive spending--on the contrary, the government has let many basic services lapse and has become erratic at best about paying its own employees (notably, and frighteningly, the military). Instead, the problem is an inability to collect taxes.

You might be tempted to attribute this inability to raise taxes to administrative incompetence in a country unaccustomed to dealing with free markets. But with its industrial base shriveled and the dollar value of gross domestic product stunningly low even before the recent collapse--last year's dollar GDP was about the same as that of Mexico--Russia's economy is now dominated by the producers of a handful of exportable resources such as oil, gas, diamonds, and gold. These sorts of traditional, homogeneous commodities are the kinds of thing that even primitive administrative systems normally are able to tax. What is more, the insider-driven process of privatization--in which state assets were in effect distributed to political supporters, much as a medieval king might assign dukedoms to his lieutenants--has led to highly concentrated ownership of these resources. It has been suggested, in fact, that seven men control about half of the country's marketable wealth. (In Russia property really is theft, pure and simple.) So in a sense all the Russian government needs to pay its bills is for those seven men, plus a fringe of smaller-scale oligarchs who would surely follow their lead, to pay the necessary taxes.

But the oligarchs own more than gas fields and banks. They also own politicians. And they decline to pay.

Asimplified account of the crisis would then run as follows. For several years now, the Russian government covered its deficits through indirect foreign borrowing--that is, foreign lenders have provided money to "banks," which in turn have lent that money to the government. The willingness of foreigners to provide this money was based on the belief that eventually the oligarchs would be willing to pay their due, and if they did the country's huge natural resources would make it possible to honor its commitments. However, in the last few months this confidence has evaporated. Foreign lenders have been willing to provide money only at very high interest rates (recently nearly triple world market rates)--and fears that the government would try to inflate away its debt, or simply default on it, led to interest rates on that (ruble-denominated) debt of as high as 150 percent. This pessimism about the government's solvency then became self-fulfilling. Given the need to pay such high rates on its debt, the government needed to borrow even more, further weakening confidence and pushing the rates still higher.

The devaluation of the ruble was a desperate attempt to buy a bit more time. By reducing the dollar value of the government's debts, while hoping to raise the ruble value of its receipts, it could narrow the financing gap. But instead the devaluation convinced everyone that the game was up and that the ruble was about to become more or less worthless, and that was that.

T he most striking thing about this story is how self-destructive the behavior of the oligarchs seems to have been. It is very much in their collective interest to have the current regime survive, so that they can continue to profit from their ill-gotten empires. Why couldn't they get together and agree to pay enough taxes to keep their rackets going?

One answer is that there is no honor among thieves--that the oligarchs are caught in a classic "prisoners' dilemma," in which it is in the collective interest of the group that everyone pay some taxes, but in the individual interest of each oligarch to free-ride on the others. Indeed, far from being a cohesive group, the oligarchs have engaged in bitter business and political struggles (which, in Russia, are the same thing). It may be hard for them to cooperate, even when it is a matter of saving the regime that made them rich.

Another answer, which may interact with the first, is that the oligarchs are not in this for the long run anyway--that at some level they all expect the game to end fairly soon, and they are simply trying to grab as much as they can. Certainly there has been massive flight of capital into Swiss bank accounts and other hidden overseas assets. (Many Russian firms maintain subsidiaries in Cyprus, the Nassau of Europe. They are presumably not there to enjoy the weather or, for that matter, to do anything productive.) Russia, as has been pointed out in this column before ("The East Is in the Red"), has generally run huge trade surpluses. Think of those surpluses as the way an oligarch's gas or oil gets converted into a billion dollar nest egg someplace outside the reach of the resurgent Communists, or Gen. Lebed, or whoever emerges from the wreckage.

One thing that is clear is that the West--the IMF, the Western governments who provided the funds for the last, doomed rescue package--have come out looking like chumps. There is a possible defense for their actions: They may have believed that the men who rule Russia were finally beginning to see the light, that in their own self-interest they would agree to cough up the money the country needed to avoid disaster, but they needed a little time. In that case the big loans organized a few months ago could have made the difference. But in fact the money quickly disappeared, as speculators--certainly including the oligarchs themselves--converted rubles into dollars as fast as the dollars became available. In effect we gave a lot of aid to some future residents of Gstaad.

Needless to say, in his recent visit to Moscow Bill Clinton repeated the old pieties, suggesting the West was "ready to offer further assistance if Russia stays with the path of reforms." And he sounded sincere.

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